tv Bloomberg Real Yield Bloomberg January 14, 2018 12:00am-12:30am EST
♪ jonathan: from new york city for our viewers worldwide, i'm jonathan ferro. with 30 minutes dedicated to fixed income, this is "real yield." ♪ jonathan: coming up, core inflation accelerates, two-year treasuries jump 2% for the first time since 2008. some of the world's most well-known investors say this might be it. the bull market in bonds is over. in credit investors are not showing any nerves. junk bonds with the largest inflows in over a year. we begin with a big issue, a shakeup in the global bond market. >> this will be a jagged period, the first quarter. >> it is not much about china
potentially selling treasuries but more about inflation showing up in the u.s., the risk that keeps most market participants awake at night. >> i think for the treasury market, it is far more important what the actions are coming out of europe and japan. >> you have not only the fed unwinding its balance sheet, we have the ecb slowing purchases, we have seen from the boj that they are making changes, which has -- as we extrapolate, slow purchases as well. >> the fed is poised to take its thumb off the scale, and poised to stop manipulating the 10-year treasury. >> $14 trillion worth of bonds bought by central banks in the past four to five years that appears to be close to an end. >> the bond market is not dead, it is just dealing in a bearish trend that a lot of people in the market haven't seen before. they have to learn how to do it. >> from our works, we have put in a structure, secular low in yields, 130, 140 on the 10-year.
but i think to say we are in a bond bear market is still premature. jonathan: joining me is matthew hornbach, priya misra, and michael buchanan. the bond bull, were you shaking this week? matthew: i don't think so. there were a couple of stories earlier in the week that scared people, sent yields higher. obviously, the inflation print this morning, a rare upside surprise. jonathan: it has been rare. matthew: a little bit interested again in the inflation story here. really, all of the things we saw this week in the bond market feed the confirmation bias of the bears. gives them everything they want and here we go. jonathan: does it feed confirmation bias to the bears? priya: i think so. i think we all came in looking for the big trade, and it is a big trade, this big bear market. i would argue not. but there is enough there.
bund yields rose. the fed was fairly hawkish. jonathan: mike? michael: certainly something, if you are bearish, we are not. at the end of the day, i think it boils down to fundamentals. when we look at fundamentals, still slow growth despite a pickup we will probably get from tax reform, inflation may be picking up but still low by historical standards. jonathan: what does this say about the nervousness in the market? first of all, it was the boj trimming a weekly open market operation. just a little bit. then there were concerns about china, what they may or may not do with treasury holdings. then after that, a tweak to a communication from the ecb. it hasn't come yet, people just worried about the prospect of a tweak to forward guidance. what does it say that people are so nervous off of the back of those very small events? matthew: i don't think it is nerves as much as this is the beginning of the year, people are ready to go, let's make money. people are basically taking this as an opportunity to increase bets for higher interest rates. the interesting thing for me
about the price action that we saw in german bunds, after this, the curve flattened. if you are worried about a steepening, or you are positioned for a steepening in the u.s. treasury market, you want the bund curve to steepen, you don't want it to flatten, but it flattened. anyone out there with steepeners in the u.s. will be concerned that the curve did not steepen. jonathan: i was going to save it for later but i will go with it now. the spread on bunds versus treasuries is wide and gets a lot of attention on the two-year space. bunds versus treasuries, but something that does not get much attention is the bund curve is twice as steep as the treasury curve. what is the story there? matthew: we are now in a position where the ecb is downshifting their purchases, it has been well telegraphed, everybody understands this. that is the first step in a normalization process that will eventually lead, perhaps, to an increase in deposit rates and further increase in the refi rates that the ecb has.
first the curve steepens and then will eventually flatten. it is already flattening, that's the interesting point here. jonathan: what is your view? priya: i would agree to the extent that the ecb will raise rates rather than reduce purchases too much, because how much does it affect the periphery? if they actually taper quickly, they stop buying. if they stop reinvesting, then it could have a pretty big impact on the periphery. the view from the market is they keep the buying program, they start normalization from negative rates, perhaps to zero. therefore, the curve should flatten. i would say the spread in the front end is all about ecb action. in the long end, that spread is too wide. treasury bonds around 2.5 basis points is arguing if prices are continuing to rise as if treasury prices can rise while bund rates stay the same. that does not seem to make sense. jonathan: let's have some thing that does not make sense to people, the amount of debt outstanding that trade for negative yield. i believe it is still around $7 trillion.
there is enough in the market to scratch your head and wonder why we are still doing this. the abnormal can stay abnormal for a lot longer than you think. michael: we have proven that. but i think what this speaks to is, you look where the u.s. is. it does, on a relative value basis, u.s. treasuries look reasonable when compared to a lot of european rates, and then you get into the spread sectors and it is probably more compelling. jonathan: was the 10-year auction evidence of that, on the back ups, will get sufficient demand? michael: that is fair to say, probably outperformed what expectations were. that is a reasonable assessment. jonathan: your view, matt? matthew: absolutely. it was just classic after all the news that we saw earlier in the week, the backup, steepening. let's face it, if the story on china had any credibility to it, which we don't believe it has, but if it did, the curve should not be steepening. it should be flattening.
because most of the securities owned in central banks across the world are on the front end of the curve. jonathan: what does this say about the response of market practitioners? there was a story about what fx reserve managers in china may do, but it was not the front end that sold off but the long end. priya: well, i actually would disagree. i think the bear steepening made sense. i would argue a lot of the buying from central banks in the last year has been in the long end of the curve. we don't have data on this. all i am saying is there is a significant amount of buying, somebody is taking the place of the fed and that is the official institutions, and the curve is flattening. i can see if i am a foreign reserve manager, do i really want to buy five-year treasuries when the market is not pricing close to what the fed is projecting? forget upside risk from inflation, so then, why would i buy the two to five-year sector? maybe i buy further of the curve. i actually think foreign central banks may have been buying the long end. if they are actually stepping away, then the curve can start normalizing.
jonathan: matt? matthew: my perspective is, you need to look at the last time central banks actually had to sell treasuries. the last time was in 2015. as priya suggested, we don't have data on what they sell, but -- on what they buy and they sell, but we know the last time the people's bank of china needed to intervene in the fx market, they were actually, we believe they were selling on the front-end of the curve because we saw dealer holdings of the securities go up. again, it speaks to the idea that if you need to let notional go, you will do it in the front end of the curve. jonathan: there is a huge political dimension to that story this week anyway, that i don't think is lost on anyone. mike, your thoughts on foreign demand, whether it is for investors -- it is foreign investors or central banks? it is not going away. michael: we are not seeing evidence of that -- institutionally, evidence from a retail standpoint. demographics support that. there is still very healthy demand broadly for fixed income. we don't see it going away. jonathan: all of you will be
jonathan: from new york city, i'm jonathan ferro. this is bloomberg "real yield." i want to head to the auction block now where we take a trip around the world. we begin in asia, where tencent sold $5 billion of bonds. its biggest u.s. dollar offering, the first time it issued debt since 2015. tencent drew comparisons to alibaba, which sold $7 billion in november.
meanwhile over in europe, monte paschi received orders to more than triple the subordinated debt it offered. the world's oldest bank sold more than $900 million a year after imposing losses on $5.2 billion of junior bonds during a government rescue. in the united states, a little order restored in treasuries, $56 billion in coupon bearings, or 30 year debt, the highest level since 2014, while the 10 year auction was at the strongest since 2016. those treasury auctions calming down a wild week in the market. the 10-year climbing to the highest level in 10 months. bill gross declared a bond bear market. >> 10-year treasuries, which are at 2.55, probably over the year will go to 2.75, 2.80 for a number of fundamental reasons. that is a bear market, but it does not really significantly affect total return in a negative way for bund investors.
it leaves them flat for the euro 2018. jonathan: still with me, matthew hornbach from morgan stanley, priya misra from td securities will and michael buchanan. your thoughts? that matthew: if 0% is a bond bear market, sign me up. i don't think that treasuries -- it is hard to draw a downtrend line for the past 25 years. jonathan: but you know we will do it. just going to draw a 25 year line for 10-year treasuries. matthew: you should do the same for the jgb market. what you will discover is that unless you expect 10 year government bond yields to go into negative territory in any significant way, eventually those downtrend lines will be broken. let's think about it from a total return perspective. if zero is the worst we can expect, then given where equities are, it is not that bad of a buy.
it is a great hedge if zero is the worst-case scenario. for a 10 year treasury yield. priya: i would agree. i would say 3% or higher is what i would define as a bear market. i think we are far from it. it is a great hedge if zero is 2.65 is already priced into the forward market. if you think 10 basis points above what forwards are pricing in, that is not a bear market i would argue. michael: i mean, it doesn't feel like a bear market for sure. if you go back a year, we were at or near these levels, great opportunity to buy duration. proved to be a head fake. that related to fundamentals. i still see the fundamentals suggesting rates are not overdone here. you could see movement lower. jonathan: looking at the fundamentals, i want to strip back what is happening with yields, and the inflation component and term premium. inflation expectations are rising, but term premiums in the u.s. are not picking up. i would have thought any recalibration in inflation expectations would have been a catalyst for higher term premium in the united states in the treasury market. wouldn't you, and what is happening there?
matthew: putting aside today, we had a great cpi report today, and breakevens are probably up based on that, as they should be. but if you look at the past three months, which is where we have seen the most dramatic widening in breakeven inflation rates, my view is that was a more nominal treasury supply story. beginning in september, the market became refocused on tax reform. tax reform was signed by the president in december, it came on the higher end of our expectations for the impact on the deficit, which means the treasury will have to issue more coupon securities, in our view. i think that is what is being priced into the market for the past three months. the widening in breakeven inflation rates was less of a global reflation story simply -- there are more nominal coupons hitting the market this year. jonathan: do you share that view? michael: i don't think i could say it any better than matt just did. i think tax reform -- we will probably talk about that -- but that definitely plays into this.
that is big and probably filtered into how the market reacted. jonathan: from a supply perspective, but what about an economic fundamentals perspective? does the tax bill change your views on the potential for higher inflation this year? michael: at the margin it does, it is additive to economic growth, but i think you have to put it in perspective. we are talking less than a half percent. the near-term benefits will be noticeable and strong, but over time, that goes away. priya: i think we heard from the fed. i think the fed needs to be taken in context. the fed is telling us they are going to hike. we heard from new york fed president dudley yesterday. not that concerned about inflation. to me, that is why breakevens have risen while inflation term premium has not. you have inflation picking up, the fed saying we are going to hike three times, we will hike in 2019, so the idea that they may be behind the curve is not there. so therefore, term premium remains low. yet inflation risk rises because
you have this fed trying to push back. the whole tax story is making them, i think marginally, more likely to hike more this year. jonathan: you all seem pretty constructive on the 10-year treasuries in the united states. mike, looking at the situation with bunds versus treasuries, a lot of you have talked about the attractiveness of 10-year treasuries versus bunds, but that advantage disappears when it is currency hedged. matthew: i think that is will accurate. you look at european high-yield trades, inside of 3%, 2.8%. that is eye-popping. you convert it into u.s. dollars, that adds about 200 basis points. you have to factor in that currency translation. it is important, but does not really take away from the story. there is a big gap between bunds and treasuries. i think that trade is exploitable. i think that is one you want to take advantage of. we are taking advantage of it.
jonathan: matthew hornbach? matthew: i would add to that, not every investor currency hedges. central banks do not currency hedge. there are pension funds in the world that do not currency hedge. there are life insurance companies in the world that do not currency hedge every currency that they invest in outside. there are different types of investors in the world, they look at things in different ways. for those that don't currency hedge, the treasury market is the best place to be. jonathan: the story for you mike, away from sovereigns and going to credit now, credit remarkably solid coming into the new year. rallied a lot higher than many people thought it would go, never mind in the first couple of weeks. maybe throughout the whole of the year. have you been surprised by the tightening we have seen in the early part of the year? michael: not really. maybe to some extent. if you look at the past two or three years, going into every year, most investors could construct a bearish story on credit. it was always around valuations. i think you have to put valuations in the context of
fundamentals, and fundamentals are very supportive. no question, and like i said earlier with tax reform, they are about to get even better. so valuations should be compressed, spreads should be tight. it is not a table pounding opportunity, but we are finding opportunities certainly with this market. jonathan: is your constuctive view predicated on a treasury market that behaves itself? michael: yes, behaves itself to an extent. i think credit can do well, reasonably well, even if rates rise. if the 10-year goes to 2.55, 3% throughout the course of the year, there is room for spread compression. if we see a quicker acceleration of that, it starts to damage fixed income and spread sectors. jonathan: quickly, if you can, mike. i had this conversation with blackrock earlier in the week, i asked, are you derisking? they say no, it is right at the bottom in equity and not in credit. are you derisking, and is there a difference between derisking and saying the optimal place is
not in credit and high-yield, but right at the bottom in equity? michael: we are derisking, and that is the byproduct of valuations. all else being equal, as they look less attractive, it make sense that you derisk your portfolio. for us, that means selectively selling high-yield, keeping our best bets on. we are keeping our local currency emerging market positions. jonathan: anything in high-yield you are selling off and you can tell us about? michael: we have been selling some of the lower quality. so if you look at the quality bias of our portfolio, we are taking gains in the triple c's, single b's, concentrating more on the double b's. we think there is an upgrade story in double b credit. we think you will see an inordinate number of upgrades from double b to triple b. that is something that investors can take advantage of. jonathan: mike buchanan will be sticking along with us alongside matthew hornbach and priya misra. let's get you up to speed on where the market has been this week.
two's, tens and 30 year treasuries are the stories. yield higher through 2% for the first time since 2008, up four basis points for the week. higher on the long end as well. 2.87 on the 30-year treasury. still ahead, the final spread, the week ahead featuring more bank earnings and a potential u.s. government shutdown. this is bloomberg's "real yield." ♪ ♪
jonathan: i'm jonathan ferro. this is bloomberg "real yield." it is time for the final spread. coming up over the next week, a shortened trading week here in the united states with equities and bond markets closed for martin luther king holiday. on a monday, you have more u.s. closed for martin luther king holiday on a monday. you have more u.s. bank earnings
starting tuesday, bank of canada decision, china gdp, and a potential u.s. government shutdown. everyone is still with me. matthew hornbach from goldman sachs, priya misra from td securities, and michael buchanan. a viewer question for you, priya. do you think the bank of canada will hike rates next week? priya: we are not looking for a hike. we are looking for two hikes this year, which is the market consensus. three or four hikes. the debt overhang and canada cannot be overestimated. a lot of their debt is floating rates. if the bank of canada hikes too fast -- if they start hiking now, the market is pricing in four hikes this year. you wonder about what all of that debt overhang does to the consumer. even though we are not looking for a hike, we are also looking for fewer hikes throughout the course of the year. jonathan: mike, getting your view on something else, the possibility for next week and the proceeding week, as well. a government shutdown could be the obsession in washington, d.c. it is certainly not the obsession on wall street. it is not on anyone's radar. it is kind of like, they will sort it out, it doesn't matter. is that your view? michael: we think that is accurate, that they do sort it out. one thing to watch closely is spending that comes as a result of that agreement. i don't think the market is
fully pricing in -- you could get some cohesion between the president and congress on military spending, nonmilitary spending, and if that comes together in a meaningful way, obviously that could be pretty powerful, that could lead to some curve steepening. we are going to watch that closely. i think an agreement is worked out by the end of the week. jonathan: matt, quickly, your view? matthew: we are of the same mindset that we do believe the government wants to try to avoid a shutdown at all costs. i mean, there are clearly some issues on the table, daca, border security, that will need to be hashed out. from our perspective, the most likely outcome is that there is a short-term extension while they continue to debate these other issues, which are important to the process. jonathan: rapidfire round. really quickly with you guys. three questions, short answers. we will wrap up the last 30 minutes and look ahead to next week, as well. do you sell into the bear market drama or do you buy it? matthew: buy it. priya: buy it. michael: buy it.
jonathan: does term premium adjust higher this year on treasuries? matthew: lower. priya: flat. michael: i will say higher. jonathan: duration risk or credit risk. it is a question i ask sometimes on this program. i think it is pertinent to this week. matthew: duration. priya: duration. michael: tough one, i am going to say credit risk. jonathan: you have got to. guys, it is great to have you with me. matthew hornbach, matthew buchanan, and priya misra. that does it for us from new york. we will see you next week at 12:30 p.m. new york time. this was bloomberg's "real yield." this is bloomberg tv. ♪ retail.
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